By Samuel Indyk

LONDON (Reuters) – The British pound was higher against a weaker U.S. dollar on Tuesday ahead of key meetings at the Bank of England and Federal Reserve, with both central banks expected to deliver large interest rate increases.

Since hitting a record low of $1.0327 in September, sterling has risen over 11% as the dollar has softened on expectations the Fed could slow its pace of policy tightening and as turbulence in British politics subsided with the formation of a new government.

“We think this move was partly related to short squeezes and some pricing out of fiscal risk premia,” said Vasileios Gkionakis, EMEA Head of CitiFX G10 Strategy.

“However, positioning is cleaner now while fundamentals remain extremely poor – and a central bank hiking into recession cannot turn the tide on the currency,” said Gkionakis.

By 0907 GMT, sterling was up 0.4% against a weakening dollar to $1.1517. Against the euro, the pound was little changed at 86.16 pence.

The dollar index, which measures the greenback against a basket of six currencies including the pound, was down 0.4% at 111.05 on improving risk sentiment as Wall Street futures and European equities traded higher.

“The British pound remains at the mercy of global risk sentiment – strengthening when risk appetite improves and weakening when it deteriorates,” said George Vessey, UK currency strategist at Western Union Business Solutions.

The Bank of England (BoE) is likely to raise interest rates by 75 basis points (bps) when it meets on Thursday, as it attempts to bring double-digit inflation back down towards its 2% target.

Money markets are fully pricing in a 75 bp rate increase at the meeting, according to data from Refinitiv, with a peak rate of around 4.8%.

However, an economy on the brink of recession, less expansive fiscal policy and a rebound in the pound have added to arguments for a smaller 50 bp rise and a lower peak rate.

“We think the BoE’s priced terminal rate … is overpriced,” CitiFX’s Gkionakis added.

“The economy is fairing quite poorly, reflected in the PMIs, while the housing market is on the precipice of a sharp correction lower,” Gkionakis said, adding sizable house price declines were usually associated with rate cuts, not hikes.

On Tuesday, mortgage lender Nationwide said British house prices dropped 0.9% in October, the first monthly fall since July 2021, as the market was hit by turmoil during former prime minister Liz Truss’s short-lived premiership.

Meanwhile, the Federal Reserve (Fed) begins its two-day meeting today and is seen raising rates by three-quarters of a point for the fourth consecutive meeting.

However, the debate over when to downshift to smaller interest rate hikes is expected to intensify so as to avoid sending the world’s biggest economy into a tailspin.

(Reporting by Samuel Indyk; Editing by Mark Potter)